When Pat Burns began his construction career in California in 1970, houses sprang forth from the ground in as little as two months, and it didn’t cost that much to get them started. Today, he says, cycle times have doubled, and he estimates that fees, labor regulations, and more stringent building-code requirements add roughly $47,000 to a typical 1,400-square-foot home—and that’s if everything goes right.
“Building impact fees are now almost 20% of our costs,” says Burns, who is talking about building in Chico, a far more affordable place than, say, Mountain View, albeit the home of Cal State and Sierra Nevada Brewing Co. “They just keep throwing more on us. If you have to do an Environmental Impact Review, that’s going to add a year onto your project and cost $50,000 to start.”
Despite the high fees, Burns has built 1,500 homes in California throughout his 46-year career. He’s constructed houses for the Irvine Co. in Orange County and worked for former NAHB president Sid Dunmore in the Bay Area and Sacramento. In Chico, where he’s overseeing the build-out of the 423-unit Creekside Landing subdivision as a site superintendent with Concord, Calif.–based Discovery Homes.
“Don’t get me wrong, I am all for mitigating the impacts of new homes,” says Burns. “But it does come with a cost. In California, it has made entry-level housing almost nonexistent.”
The data back Burns up. According to Alan Ratner, an analyst with New York–based Zelman & Associates who recently surveyed builders about fees in 37 markets nationally, California housing companies are being squeezed between the state’s high impact fees—which he pegs as the highest in the nation—and the lowered Federal Housing Authority (FHA) loan limits that came out in 2014, which set a de facto benchmark of affordability for first-time home buyers.
“Depending where you are in the California, you’re in the hole by at least $50,000 before you even put a shovel in the ground,” Ratner says. “That makes it really challenging to build an affordable product there.” Typical fees in San Francisco are $72,600 per home; in Sacramento, they’re $62,000. And for the six California markets highlighted in the Zelman & Associates report, the average is $51,650. That’s nearly two-and-a-half times the national average of $21,000. And the Zero Net Energy homes mandate, on the horizon for 2020 in California, could add an additional $25,000, or more, to the cost of building a home.
The average new-home price in California now stands at $621,135, according to San Clemente, Calif.–based Real Estate Economics, which surveys all new-home communities across the state on a quarterly basis. That’s 73% higher than the national average new-home price of $358,200 in June of 2016, according to the U.S. Census Bureau.
Tie that into the fact that housing demand continues to rise, and building houses for first-time home buyers in the Golden State has become akin to so many other California dreams, like finding fame on Hollywood Boulevard or becoming an overnight billionaire in Silicon Valley: still possible, but with the odds stacked heavily against most comers.
The Problem
The cumulative $75,000 in added costs from fees and building code requirements is just a fraction of what has contributed to the staggering price of housing in California. The rest comes simply from supply and demand, or more accurately, a lack of supply that has run into a torrent of demand. The collision of the two has helped create, in a convoluted way, the state’s ever-increasing fee structure that builders in California like Burns face.
“At the highest level, California has had a policy in place for decades that has restrained the supply of housing and driven up the cost,” says Chuck Reed, former mayor of San Jose, where the median home cost $760,000 in April, according to CoreLogic. “It’s simple supply and demand. And surprise, supply and demand works.”
According to a widely referenced 2015 report from the California Legislative Analyst’s Office (LAO), the Legislature’s nonpartisan fiscal and policy analysis arm, since 1980, California has built half of the housing units it needed—about 100,000 per year—to keep up with demand. And that’s just in aggregate. In high-demand locales like the San Francisco Bay Area and Los Angeles, the housing deficit is even greater. “Most of California’s coastal counties needed to build three times as much (or more) housing as they did,” the report claims.
Stated differently, during the past 36 years, California did not build the additional 3.6 million homes that it needed to keep its skyrocketing prices in check. To put that number in perspective, it would take the collective efforts of every home builder in the country, building nonstop at 2016’s projected pace of 1.26 million housing starts, three years to put a dent in the state’s problem.
The report concludes that NIMBYism, local communities’ lack of financial incentives to approve more housing, and anti-growth proponents who go to daunting lengths to block development have contributed to the problem, as well as more inveterate challenges such as a scarcity of suitable land along the coast and an ever-increasing population.
The LAO report found that the average cost of homes in California is two-and-a-half times higher than the rest of the country, and rents are 50% higher. It also points to evidence that high housing costs were making it difficult for companies to recruit employees, even in Silicon Valley, and threatened the state’s jobs base. Other reports that came out in its wake highlighted a net migration of 625,000 people out of the state from 2007 to 2014, primarily among lower income earners, attributed to housing costs.
All of which leads to the question, how did California get to a place where it tacks $75,000 onto the cost of a new home in the midst of a housing crisis that’s eroding its jobs base and pushing the country’s most populous state into an unwinnable war of the haves and have nots?
Dutch, CEQA, and the Law of Supply and Demand
The place to start answering that question, it turns out, can be found back in 1970, the same year Burns got his start banging nails in Orange County. That’s when the events were set in motion that led, however indirectly, to California having the highest impact fees in the country today. And it’s the year, according to the LAO, that marks the true start of California’s current housing crisis.
According to the LAO, California home prices, while still 30% higher than the rest of the country, increased at about the same pace as the national average until 1970. That year, they began to accelerate until they were 80% higher in 1980, and twice as high in 2010.
That acceleration started, as is the case with many aspects of California’s modern political landscape, under the administration of Ronald Reagan. In 1970, the then–California Governor signed the California Environmental Quality Act (CEQA), the state’s broad development review mandate, into law. It’s been at the heart of California’s housing shortage ever since.
Modeled after the National Environmental Policy Act (NEPA) of 1969, CEQA originally was cast as a progressive mandate that would protect the rolling hills, towering forests, and jagged coastlines that make California so unique. It obliged local municipal bodies to consider environmental impacts before approving new housing projects, and if any were found, to require developers to come up with a plan to mitigate those impacts.
But what CEQA has become, housing advocates say, is a bludgeoning club used by anti-growth and NIMBY interests, as well as labor groups, to either block development outright or hold developers hostage to their concessions.
“I call it the California Extraction Quantity Act,” says Reed, the former San Jose mayor. “It’s the primary tool used to obstruct housing and drive up the cost of housing, because of the threat of litigation. Under CEQA, it’s easy to litigate and easy for developers to lose.”
CEQA’s effect on housing has been so widespread that in 2013, the San Francisco Chronicle called for legislators to “stop the exploitation of an environmental law to achieve objectives (such as unions using lawsuit threats to coerce labor agreements) that have nothing to do with the environment.”
[Editor’s note: Not everyone agrees with the notion that CEQA has had such a negative effect on housing. A new study, released in August by the Rose Foundation for Communities and the Environment and conducted by BAE Urban Economics, asserts that CEQA has had minimal effect on the new-housing market. The report can be accessed at https://www.pcl.org/media/CEQA-in-the-21st-Century.pdf. ]
The newspaper railed against CEQA’s duplication of project reviews, and how it’s been used to slow or stop even environmentally friendly projects, such as a San Francisco plan to add 34 miles of bike lanes. It cited a battle in San Jose, where a labor union plied CEQA to stop a downtown high-rise project “to pressure the developers not to use out-of-area subcontractors.” At the time, Reed described the episode as “an abuse of the environmental process.”
But even when developers do get past CEQA, it takes time and mountains of cash. Highpark, a 676-unit development in Los Angeles’ San Pedro area being developed by iStar, finally broke ground in April, a year after the first houses were supposed to be completed there. The project’s CEQA review took three years and added at least $3 million to the cost of the development, according to Steve Magee, iStar’s executive vice president of land and development. That equates to $4,400 per lot, without turning dirt, and is separate from hard development costs.
“I don’t have a problem with completing the reviews to make sure a project is done right,” Magee says. “But the issue is, a lot of developers don’t have the staying power and deep enough pockets to go through it. So it shakes off potential projects, or makes proposed projects smaller, which results in fewer homes getting built in a market that is screaming for housing.”
To wit, developer Bob Bisno in 2005 originally envisioned Highpark as a stacked community of 2,300 homes on what used to be Navy land. But that proposal ran into a wall of protests, and eventually produced Highpark, which will have two-thirds fewer houses with prices ranging from the high $600,000s to more than $1.2 million. The first homes should be available in 2017.
Magee, who started his career as a city planner in Florida before working in Texas for Centex Homes, says land and development costs in Southern California run as high as 40% to 45%, and sometimes up to 50%, of a home’s final number. “If your home price is $800,000, you might have a finished lot cost of $400,000,” Magee says. In Texas’ Dallas-Fort Worth market, by comparison, he says lot costs represent only about 20% to 25% of home prices.
Over the years, there have been efforts to amend CEQA, including a push in 2013 by Gov. Jerry Brown that came up short. He called CEQA reform “the Lord’s work” at the time.
Brown was calling for a “by right” exemption of CEQA review for urban projects in areas that have already been zoned for high-density housing and include a sliding percentage of affordable units, depending on proximity to transit. It would have essentially given such projects “ministerial” approval and strip local boards of the power to block them. Brown tied the proposal to the state’s budget, but to no avail. At press time, the law was considered all but dead, at least for this legislative session. This despite the fact that the state legislature is under the control of Governor Brown’s political party.
Powerful lobbying groups were arrayed against the proposal. “It’s a back channel way to get around CEQA,” says Dan Carrigg, legislative director of the League of California Cities. “This proposal takes all local discretion out of the approval process.”
Housing proponents say that’s exactly the point. “Most cities want to limit growth, not increase it,” says Reed.
The State Building and Construction Trades Council of California (SBCTC), which is often accused of using the threat of blocking projects with CEQA to get contracts from developers, considered by right exemption a bad idea for California’s environment.
“By right gives developers a blank check,” says Cesar Diaz, legislative and political director at SBCTC. “No matter where you live, having a standard like CEQA in place is critically important. Our members are people who live in the community. They’re middle class. We want them to have not only quality of life, but also economic opportunities through jobs. And we don’t want them to have to live in areas where development is harmful.”
Howard Jarvis and Proposition 13
While CEQA and environmental reviews add millions in costs to housing projects, the localities that have the power to approve or block them don’t get any of that money. They also get a much smaller slice of the property taxes that often incentivize communities in other states to approve new development.
“Cities will tell you that from a property tax perspective, housing is a loser,” says David Cogdill, president of the CBIA. “You’ve created a situation where property values are going up, but the localities don’t benefit financially.”
The reason for that is Proposition 13. Voters passed the law in 1978 to cap the rate at which local property taxes can increase, and effectively put the state in charge of dolling out the money once it was collected.
Sponsored by the Howard Jarvis Taxpayers Association, whose founder once appeared on the cover of TIME magazine with a raised fist under the headline “Tax Revolt!,” the initiative was originally aimed at making sure existing homeowners, especially retirees on a fixed income, didn’t get taxed out of their homes. A subsequent measure required all local government tax increases in California be approved directly by voters.
With that structure in place, cities often favor commercial or retail development over housing, because they get a larger portion of the sales and other taxes those projects generate.
“Local governments all want more jobs, but we don’t want more housing,” Reed says. “We make money off of employment. We lose money on housing, which puts a demand on services. We all pretend that jobs don’t create demand for those services, too, because those workers are presumably going to live somewhere else. We just don’t know where.”
That process also explains, in a way that’s as convoluted as California’s revenue structure, why the impact fees Burns and other builders pay in the state are so high. Basically, cities can either block housing with CEQA and not incur the extra costs of services housing creates, or approve that housing, but raise impact fees, which are the last best option that remains for them to increase funding.
“Essentially, cities can’t raise the property tax at all, and if they want to raise any other type of tax, it requires voter approval,” explains Brian Uhler, an analyst at the LAO who co-authored its 2015 report. “So in California that results in higher fees on developers because that is the path of least resistance for localities to raise revenue.”
As the kicker, because CEQA has stopped so many homes from being built over the years in California, any impact fees imposed on houses that do get out of the ground inevitably go up, because they’re spread across fewer units instead of the entire tax base. That, in turn, adds to per-lot costs because fewer homes are built. “Cities only get one bite at the apple, and they take that bite at impact fee time,” iStar’s Magee explains.
Kris Vosburgh, executive director of the Howard Jarvis Taxpayers Association, says the argument that Prop 13 contributes to California’s high home prices is just another “urban myth” that opponents use to smear the law.
“You’re getting input from morons,” Vosburgh counters. “Local officials behave stupidly and make bad decisions, so that’s Prop 13’s fault? Prop 13 has absolutely nothing to do with the housing supply in California.”
Only in California: How Zero = More
It doesn’t appear that building affordably will get easier any time soon. With California’s goal to have all new homes be zero net energy (ZNE) compliant by 2020—meaning they’ll produce as much energy as they use—add-on costs for builders will only go up from here. Bob Raymer, a senior engineer and technical director with the California Building Industry Association (CBIA), says ZNE could add another $20,000 to $25,000 to the construction of homes in the state.
The California Public Utilities Commission (CPUC) and the California Energy Commission (CEC), both run by boards appointed by the Governor, introduced those goals in 2007, and gained broad support from both former Gov. Arnold Schwarzenegger and current Gov. Jerry Brown. Since the CEC sets the energy efficiency standards for the state’s building code, the goals likely will become compulsory by 2020.
The CPUC has estimated ZNE will add anywhere from $2 to $8 per square foot to the cost of a California house—the top end of which would add $11,200 to Burns’ typical 1,400-square-foot home.
For its part, the CEC hasn’t put a number on the costs it will add to the building code in 2020. But when asked how it can justify the additional costs for homes that are already priced beyond the means of many Californians, a commission spokeswoman pointed to the fact that all ZNE components need to pay for themselves over the 30-year life of a home. So any extra costs home buyers incur up front, they’ll get back over time.
“Everything we adopt into the code has to be cost effective and technically feasible,” says Amber Pasricha Beck, public information officer, energy efficiency, for the CEC. “It may be possible to reach zero net energy in some environments, but not in others. In some cases, it may not be cost effective.”
California Dreamin’
When a situation is dire, an optimist’s usual response—and Californians are nothing if not optimists—is that things can only get better. Which makes it all the more troubling that no one is saying that about the housing situation in California.
“We characterize it as unsolvable,” says John Mulville, vice president of consulting for Real Estate Economics. “When we speak to California audiences, we tell them, if you own a home in California, don’t sell it. We have a serious undersupply that cannot be remedied. As long as people keep coming here, even if the economy isn’t great, the price of your house is going up.”
Then, there’s Senate Bill 50, which establishes a three-legged stool to fund schools through local bonds, a state match, and development impact fees. But with state funding for that program drying up, another $15,000 to $30,000 could be tacked on to development fees, according to Zelman & Associate’s Ratner. If that happens, it would bring the running tally of added costs of building in California tabulated in this article as high as $105,000 per unit. The CBIA has been working to launch a new bond program in its place, but that will require voter approval this fall.
Finally, amendments to Senate Bill 32, if approved, could tack on more. The bill, as part of the California Global Warming Solutions Act of 2006, would require California’s greenhouse gas emissions to be curtailed to 40% below 1990 levels by 2030, and 80% below by 2050.
If approved, that would add $58,000 onto the cost of building a home in California, according to a 2015 study commissioned by the CBIA, though many of those costs would overlap with the goals for ZNE homes already in place. (Cogdill adds that changes to the bill since the CBIA report came out last year could temper costs, too.) State Sen. Fran Pavley (D-Agoura Hills), the sponsor of the bill, didn’t immediately respond to a request for comment for this article.
Still Hammering Away
Back in Chico, all the new costs, requirements, and wrangling to get projects approved add up to a categorically different California home building industry than the one Burns started out in, where houses cost more than what first-time home buyers can qualify for and take twice as long to build.
“In the 1980s I could manage a 40-house project myself,” says Burns. “I could build a 2,700-square-foot home in 60 days without a computer or a cell phone. Now, I spend most of my time at the computer, and it requires having an assistant superintendent to deal with all the paperwork.”
In other words, Burns is left banging away at the keyboard instead of banging nails to pay for the privilege of building the homes California needs.
Unlikely Regulators
No person of sound mind could possibly assert that Ronald Reagan was a proponent of regulation. When he signed the California Environmental Quality Act (CEQA) in 1970, he was running for re-election in an openly hostile environment, having frozen state hiring and raised taxes. He battled student protestors over myriad issues, including the attempted imposition of a modest tuition at state colleges, which until then had been free. He was a politician, politicians need to get elected, and the CEQA—coming on the heels of the passage of the National Environmental Policy Act—was a means to that end.
The same went for Howard Jarvis. Though he positioned himself as an everyman, he was a politician. Jarvis’ goal, amid a rapid run-up in home values, was to stop spiraling residential tax assessments and the soaring property taxes that resulted. His product, Proposition 13, was passed by California voters in 1978. His modus operandi was to slap a lid on revenue with the assumption that it would cap government spending. It didn’t.
Here, in an excerpt from a BUILDER article written in May by Adam Deermount, co-founder of Landmark Capital Advisors in California, is how Prop 13 has affected entry-level housing (full article here):
In 1978, nearly two-thirds of the state voted to reduce the property tax to 1% of the value at the time that the real estate was purchased … and capped future increases to no more than 2%. It also took the responsibility for allocating property taxes from local municipalities and transferred it to the state. Prop 13 was intended to avoid the New Jersey scenario of people getting taxed out of their homes. In that regard, it has been a success. However, it created a major market distortion and provided fuel that helped property values soar.
It also led to a decrease in local revenues and forced local governments to rely increasingly on impact fees to mitigate the impacts created by new development. In other words, local governments could no longer rely on spreading the cost of new infrastructure across an entire tax base, they now had to focus the cost solely on new development, which constitutes a much smaller number of units. It also means that a local government only gets one bite at the proverbial apple via impact fees rather than a recurring income stream that can be assessed upward as need dictates.
This “one bite” mentality provides an incentive for local governments to hike non-recurring fees to pad a highly irregular income stream, shifting the full infrastructure burden to new units to the benefit of existing ones.
Prop 13 didn’t actually force a reduction of government as many claimed it would. Instead, it merely shifted the burden of funding the local government from many to few, and home builders and land developers are paying the price for that today.
In a market like coastal California, with highly restricted zoning and astronomical land and home prices, Prop 13 provides a huge incentive for homeowners to stay put rather than move since they can’t take their [capital gains tax] basis with them (aside for a provision that allows older homeowners a one-time basis transfer). This leads to the scenario where a home could have an assessed value of less than $100,000 and a market value of several million dollars while an identical house next door is worth $2.5 million and has an assessed value of $2.5 million.
There was a time when coastal cities in California had entry-level housing stock. Today, those starter homes are getting knocked down or renovated by their owners since there are incentives to stay put. When they do sell, the homes are often bought by buyers who rebuild or renovate, or developers that do the same to sell at a higher price. As a result, the older, entry-level housing stock near the coast is long gone, and we are now stuck relying on new construction in inland locations where it’s nearly impossible to build affordably because impact fees are so high relative to home prices.
Large, sweeping statutes like Prop 13 have consequences that continue to manifest decades after they are passed. In this case, it’s a dearth of entry-level housing.
